Posted on 06/02/2003 4:23:28 PM PDT by Dog Gone
With mortgage rates setting new lows last week, a growing number of homeowners are doing something that was largely unheard of just a year ago: taking out 10-year mortgages.
It's part of a broader push by many borrowers to pay off their mortgages quickly by taking advantage of the lowest interest rates in more than 40 years. Some are baby boomers who want to get rid of their debt before they retire. Others are simply trying to save on interest costs by shortening their mortgages.
The interest savings on a 10-year mortgage are enormous. If someone borrowed $250,000 at 4.5 percent, the going rate at a major lender, the interest over the life of the loan would be only $60,915. By contrast, in the case of a homeowner borrowing that same amount for 30 years at 5.375 percent (longer-term loans typically carry higher rates), the interest would total $253,974.
The drawback, of course, is that your payments are higher in the short term. On that same hypothetical $250,000, the monthly payments would be $2,591 with a 10-year loan, compared with $1,400 for the 30-year loan.
At Countrywide Home Loans, a unit of Countrywide Financial Corp., 10-year mortgages now account for roughly 15 percent of mortgage loans. The volume of 10-year loans "was insignificant a year ago," says Doug Perry, first vice president of Countrywide Home Loans.
To spur demand, Countrywide has been sending direct-mail solicitations explaining the benefits of shorter loans to borrowers who are prepaying their existing longer-term mortgages.
Borrowers have been gravitating to 15-year mortgages from 30-year loans for some time. But the new 10-year loans are providing a fresh inducement even for people who have refinanced relatively recently.
Rich Schroeder, an account manager for a transportation company, took out a 15-year mortgage with a 6.5 percent rate last year. Now, he is switching into a 10-year, $116,000 mortgage with a 4.875 percent rate.
"I'm looking to get out from underneath the mortgage as quickly as possible," says Schroeder, who lives outside Detroit. The new loan will allow Schroeder to pay off his loan nearly four years earlier, while adding only $100 to his monthly payment. Schroeder says he considered refinancing four or five months ago, "but it wasn't worth making a move."
Earlier this year, the mortgage industry braced itself for a sharp decline in refinancing activity as the economy seemed poised to recover, which would drive rates up. Instead, the economy has remained soft, and fears of deflation have pushed rates to their lowest levels in decades.
The result is that refinancing activity is surging. The Mortgage Bankers Association recently boosted its estimate of 2003 mortgage volume to $3 trillion, up from last year's record $2.5 trillion.
Interest in the shorter loans is helping spur the latest round of refinancing. In April, U.S. Bank Home Mortgage introduced a 10-year fixed-rate mortgage that carries a lower rate than its 15-year mortgage; previously, the two mortgages carried the same rate.
"Our phone literally has been ringing off the hook," says Dan Arrigoni, president of U.S. Bank Home Mortgage, a unit of U.S. Bancorp.
Shorter-term mortgages of all types are gaining ground. At GMAC Home Finance, a unit of General Motors Corp., 15-year mortgages accounted for nearly half of recent refinance loans. Last year, about 20 percent of GMAC customers who refinanced opted for a 15-year mortgage. Chase Home Finance, a unit of J.P. Morgan Chase, says 15-year mortgages now account for about 20 percent of the loans in its pipeline, up from 15 percent six months ago. More borrowers also are refinancing their 30-year mortgages into 20-year and 25-year loans, lenders say.
On Tuesday, rates on 30-year fixed-rate mortgages averaged 5.51 percent, while 15-year fixed-rate loans averaged 4.95 percent, according to HSH Associates, financial publishers in Butler, N.J.
Mortgage rates could drop even further if the economy shows further signs of weakness. Mortgage rates typically track rates on Treasury bonds.
Of course, many homeowners aren't interested in shorter mortgages. Instead, they are using the low rates to lower their monthly payments. Or, they are taking cash out when they get a new mortgage.
Indeed, short-term mortgages aren't for everybody. Borrowers are committing to a higher payment for the life of the loan. If a homeowner's income drops, she will still have to make that steeper payment.
You can achieve some of the same benefits of shorter-term mortgage simply by taking out a 30-year mortgage and making extra principal payments. Pinched for cash? Make the minimum payment. One hitch: You typically won't get as low a rate on a 30-year mortgage as on a shorter-term loan. And many find it hard to stick with this self-imposed mortgage prepayment strategy.
In addition, people taking out a 10-year mortgage will quickly whittle away one of their biggest tax breaks: the deduction for mortgage interest. Principal payments aren't tax deductible. In the first year, the interest deduction for a 10-year mortgage at 4.5 percent is only about a fifth smaller than a 30-year mortgage at 5.375 percent. But by the fifth year, a borrower in the 27 percent bracket would see the deduction cut almost in half, calculates PricewaterhouseCoopers.
Borrowers don't always get a break for taking a shorter-term mortgage. Twenty-five-year loans are typically priced at the same rate as 30-year mortgages. Likewise, Bank of America Corp. offers the same rate on 10-year and 15-year loans. As a result, the bank says its customers are more likely to take out a 15-year mortgage and pay it off early if they are inclined.
Still, for many borrowers, a shorter-term loan has clear benefits. It allows homeowners who are several years into their current mortgage to take advantage of low rates without stretching out payments for another 15 or 30 years.
Don Genereux, an elementary school principal in Minneapolis, is replacing his $88,000 fixed-rate mortgage, a $25,000 home equity loan and some high-cost debt with a new $115,000, 10-year fixed-rate mortgage with a 4.375 percent rate. The new loan will boost Genereux's monthly mortgage payment by about $15 but cut his total borrowing costs by about $500 a month. Genereux, 55 years old, says he was already five years into his 15-year mortgage and didn't want to extend his loan further. "We're looking at retirement and change of career," he says. "We need to have a light at the end of the tunnel."
BTW, I'm not totally discounting the idea of eliminating debt. I'm debt free except for my mortgage. But mortgage rates are at historic 40+ year lows. Why not take advantage of it?
Ask him to figure out how much interest you would pay on a 30 year loan and another report on how much interest you would pay on a 10 year loan.
Then, ask him to print out a report on how much interest you would pay if you got a 30 year loan and made the 10 year payments.
Then report back to me. I am willing to go out on a limb and say you will be astounded at the savings.
Doesn't a VA guaranteed loan demolish this requirement ?
The effective interest is immaterial. You're still out over $121k. If you take out a 15 yr loan at the current rate of 4.5%, your interest would be $56,548. Lop off that 30% and you're still out $39,584. $121,630-39,584=82,046. That $82,046 is money paid on interest that will never do anything for you.
If your loan is sold off, you have no choice in the matter, other than to refinance somewhere else. My loan is with AlaskaUSA FCU. Never had a problem with them, ever. I make my payment online each month from the comfort of my home. And they rarely sell off real estate loans.
But I don't want to sell my house - I like it.
If I'm stashing money away in cash along the way, I can use that during any low periods and I get to stay.
Don't misundertand me. I'm not saying you SHOULDN'T take advantage of this opportunity. I am simply saying there is a way to save even MORE by going with a 30 year loan and making the 10 year or 15 year payments.
Ask a loan officer to print out reports under the 3 scenarios:
1) Total payments broken down by principal and interest on a 30 year loan
2)Total payments broken down by principal and interest on a 10 year loan
3)Total payments broken down by principal and interest on a 30 year loan if you make the 10 year payments.
Then I guess your kids pay their own way through college.
That's exactly the point. Borrow money cheaper than you can make it. Rick makes some additional liquidity arguments which have merit as well.
That is often true, but it really hasn't been true in the last couple of years. If you had invested that money in the stock market, you might well have negative returns.
Sure, but
a) you don't have to invest in the stock market and
b) you don't look at short-term returns in mortgage comparisons. Afterall, the mortgage isn't short term. Let's compare that effective interest rate and the stock market returns in 30 years... that's the point.
And, unless you're investing in some tax-sheltered investment, you have to consider what your after-tax return really is.
True, but take the extra money and put it in a Roth IRA and whatever return you get IS your after-tax return. What's more, if you don't invest in a tax-deferred vehicle, almost every investment you can make qualifies for capital gains treatment (stocks, bonds, real estate, etc) [ok, so real estate is a sec 1231 asset, but let's not get picky here, ok?] :)
Look at my calculations in post 22. I don't think I can guarantee a 20% return on my money for the next 10 years anywhere else. Where am I wrong?
You're not wrong per se, you just need to consider every variable. See below.
Well, I ran the numbers, and I'd save almost $100,000 if I go to a 10-year note at 4.5%. However, it would cost me about $400 more per month.
That's a little less than $5,000 per year. Kinda thinking out loud as I'm typing, that's paying $50,000 early over 10 years to save $100,000, or a 200% return on my investment. Annualized, that's 20%, something which I never got during the stock market boom of the late 90s.
Well, to begin, the return is 100% (50,000 returns $50,000, or $50k/$50k = 1 = 100%). Annualized that's a 7.178% return over 10 years. But that's beside the point.
Ok, we'll look at this from all angles. First, your savings isn't really $100,000, because you have to factor in the tax savings too. Because the $100k you "save" can only be interest, that number is reduced by whatever your marginal tax rate is (since I don't have that number, you'll have to calculate it for yourself). Probably the effective savings is around $70,000.
Additionally, you have to look at what your potential earnings would be if you put that $5000 per year for 10 years into some other investment. You are, afterall, choosing to "invest" it in your mortgage, so what happens if you choose to invest it elsewhere?
Starting with $0 and contributing $5,000 annually to a portfolio averaging 8% annually would net you $72,432 after 10 years. Even a conservative 6% would net you $65,903.
So basically, you'll break your back to make that 10-year monthly payment to break even on what your money would have done elsewhere for 10 years But, if instead you had used the difference between the 10 year payment and your 30-year payment over the entire 30 years, you get the tax deduction, the growth, and the liquidity that Rick is talking about. I'm not going to go into all those numbers, because I'm tired and this is long enough already :)
Just talk to several knowledgable financial advisers before jumping into a 10-year note. You may decide it's what you want, and you may not, but at least you'll have all the facts. HTH,
Jeff
I don't get a kickback or a bird-dog fee or anything. He's just a great guy.
Or, talk to the bank that currently has your mortgage. You might save yourself hundreds of dollars in paperwork fees.
Let me know if you want the guy's name and number.
Flame Away
That's mind boggling when you think about it.
My parents paid $8,000 for their house in 1969 (they still live there). They looked at a bigger house up the street, but it was $12,000 and out of their price range. Their mortgage payment was $95/month.
Their $8,000 house would probably sell for $70K or $80K - almost 10x what they paid.
It's hard to imagine the same thing happening with current prices. Will my $200K house be selling for $2 million in 30 years? It boggles the mind....
I don't know the details, but yes I believe you are correct: this is for conventional loans only.
The only thing I wish I would've done differently was talk to our bank after I got all the figures from the person who eventually refinanced our mortgage. I might have been able to save a few hundred dollars in paperwork fees. I'm not 100% sure of that but I think so.
Don't worry about hurting anyone's feelings. They are going to make tens of thousands of dollars off of you.
What he is advising is that we all become investment bankers, spending 40 hours per week investigating and making investments. And, his theory is based on an 8% return on the money invested. Not a bat theory if that's what you want to do. How many of us have the time or the wherewithall to do this?
I will leave you to consult with Rick Edelman, Ray Lucia, and financial planners worth their salt everywhere. The simple fact is that if you can borrow money at an effective interest rate of cheaper than you can make money, wouldn't you want to do that for as long as possible?
If I would loan you money at 4.5% for 1 year and you know you would make 6,8,10% on that money that year, you'd do it right? Would you do it for 10 years? You'd probably ask me to do it for life if I'd be willing, right? This is what the bank + government is willing to let you do if you're only quick enough to realize it.
Jeff
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